The year of 2008 was supposed to be filled with joy and pride for China, in celebration of the 30th anniversary of the nation's economic reform. Instead, the financial crisis in the West and the resulting global economic downturn is pressuring China — the world's factory and powerhouse — to rescue its export sector and rework its growth strategies.
Recessions in the United States, Japan and Western Europe are battering Chinese exporters. Since exports have been the main growth drive of China's gross domestic product, reduced demand from abroad is immediately denting GDP growth, which dropped to single digits during the first three quarters. Forecast growth for 2009 has fallen into the 7-9 percent range.
The market slowdown was the last straw for China's manufacturers, which already had been in trouble due to overcapacity and poor profit margins. Unfortunately, China has become a victim of its own success. The rush of investment into factories quickly drove up costs — within China, labor, land and utilities became more expensive; on the global scale, raw material and energy prices went through the roof. Even the Chinese government started to use tax disincentives and stricter regulations to discourage dependence on labor-intensive exports. But most exporters carried on with a grin-and-bear-it attitude, with the hope that their growth would make up for razor-thin margins. The overstretched companies were vulnerable when the crisis hit.
Moreover, China's manufacturing boom generated a tremendous surplus of U.S. dollars, which not only created an enormous foreign currency reserve in Beijing but also overheated China's financial market and real estate industry. Hoping for quick and big return, manufacturers pulled cash out of production — on the books or not — and ``diversified'' beyond manufacturing. China's largest resin compounder, Kingfa Sci & Tech Co. Ltd., for example, acquired Gaosin Real Estate last summer and injected cash into the unit. While Kingfa's compounding business maintained nice growth in fiscal 2007, the real estate unit dragged the company's cash flow to $125 million in the red. Now that China's housing market is cooling down, Kingfa is unlikely to get the return it expected from Gaosin, and its unhealthy cash flow may hold back its compounding business.
If Kingfa's expansion is raising red flags, investment failure has already put some other firms out of business. Stars Arts and Crafts Co. Ltd., a $40 million exporter of plastic home decor items, had its factory in Xiamen, in the Fujian province, taken over by a local court in October. Chinese media pointed out that the company's owner lost large amounts of money in currency trading and fled out of China.
Leading toy manufacturer Smart Union (Group) Holdings Ltd. also recently shuttered three factories in the Guangdong province with a combined workforce of 8,700 and blamed resin price and wage increases, exchange rates, etc. However, beyond the obvious challenges for the industry, Smart Union's real problem was exhausted cash flow, which can be attributed to a confusing $40 million cash purchase of minority shares of China Mining Corp. — whose main asset was the ``exploration right'' [not mining right] of an undeveloped silver mine.
If cost control on the factory floor is Chinese manufacturers' strength — for good or bad — then financial management and discipline is their Achilles' heel. Behind the mismanagement and investment failures, I see lack of long-term vision and excess greed, neither of which is conducive to innovation, brand-building or sustainable growth.
As the current financial crisis sweeps out the weaker players in the market, the Chinese government should take advantage of it, push for more effective regulatory systems, and create an environment that rewards the creation of value beyond export-led contract manufacturing that can't live without government subsidy and lax regulation.
But it's easier said than done, isn't it? I'm sure Beijing is fully aware of the problems that can plague China's future growth, so the reform needs to go on and go deeper. China's next 30 years won't be any less challenging.